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Is KB Home's Stock Cheap or Expensive by the Numbers?

Let's take a look.

Numbers can lie -- yet they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

The current price multiples.

The consistency of past earnings and cash flow.

How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap KB Home(NYSE: KBH) might be.

The current price multiplesFirst, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.

Then we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow, which divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). As with the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

KB has negative P/E and EV/FCF ratios over the trailing 12 months. If we stretch and compare current valuations with the five-year averages for earnings and free cash flow, we see that KB has a negative P/E ratio but a five-year EV/FCF ratio of 3.0.

A positive one-year ratio of less than 10 for both metrics is ideal (at least in my opinion). For a five-year metric, less than 20 is ideal.

KB has a mixed performance in hitting the ideal targets, but let's see how it stacks up against some of its competitors and industry mates.

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

KB Home

NM

NM

NM

3.0

PulteGroup(NYSE: PHM)

NM

NM

NM

4.9

Toll Brothers(NYSE: TOL)

39.1

NM

NM

10.6

Lennar(NYSE: LEN)

32.5

504.4

NM

11.0

Source: S&P Capital IQ; NM = not meaningful because of losses.

Numerically, we've seen how KB's valuation rates on both an absolute and relative basis. Next, let's examine ...

The consistency of past earnings and cash flowAn ideal company will be consistently strong in its earnings and cash-flow generation.

In the past five years, KB's net income margin has ranged from -34.4% to 0.8%. In that same time frame, unlevered free cash flow margin has ranged from -19.1% to 23.1%.

How do those figures compare with those of the company's peers? See for yourself:

Source: S&P Capital IQ; margin ranges are combined.

In addition, over the past five years, KB has tallied up one year of positive earnings and four years of positive free cash flow.

Next, let's figure out ...

How much growth we can expectAnalysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you willoverpay for stocks. But even though you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared with similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. Because of losses, the trailing growth rates for KB Home and Pulte aren't meaningful. Meanwhile, the growth rates for Toll and Lennar are dismal:

Source: S&P Capital IQ; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: S&P Capital IQ; estimates for EPS growth.

The bottom lineThe pile of numbers we've plowed through has shown us the price multiples that shares of KB are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a negative P/E ratio ,and not surprisingly, the initial numbers are ugly almost all around. We do see a really interesting five-year EV/FCF ratio of just 3.0. But even that comes with a qualifier. The free cash flow exceeded earnings in previous years because of non-cash inventory writedowns and inventory sales. The homebuilders remain on my radar for a contrarian opportunity, but buying into a homebuilder involves the next steps of getting comfortable with its balance sheet, plans for the future, and some thought to the overall housing market.

If you find KB Home's initial numbers or story compelling, don't stop here. Continue your due-diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.